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|"The Application of the Theoretical Apparatus of Supply and Demand to Units of Currency"; Cannan, Edwin|
8 paragraphs found.
|The Application of the Theoretical Apparatus of Supply and Demand to Units of Currency|
I have used what will perhaps appear a somewhat clumsy phrase in place of the more familiar "Laws of Supply and Demand," or even the "theory of the relation of demand and supply to value," because I think it desirable to suggest that "Supply and Demand" are heads of arrangement rather than the name of a doctrine. When we say that the value of a thing depends on supply and demand, we do not, or at any rate ought not, to mean more than that we think it will be convenient to arrange the causes of changes in value under those two heads.
The stock of some things (such as milk, or even wheat) in hand at any one moment is so small in proportion to the annual produce, that we think of the stream of produce as furnishing the supply, and the ability and willingness of people to consume the thing as furnishing the demand. Of other things, such as land and railways, the annual production is so small compared with the stock, that we think of the stock as furnishing the supply, and the ability and willingness of people to use the thing as furnishing the demand.
Following the same line with demand, we must think of the demand for currency as being furnished, not by the number or amount of
transactions, but by the ability and willingness of persons to
hold currency, in the same way as we think of the demand for houses as coming not from the persons who buy and re-sell or lease and sub-lease houses, but from the persons who
occupy houses. Mere activity in the house market—mere buying and selling of houses—may in a sense be said to involve "increase of demand" for houses, but in the corresponding sense it may be said to involve an equal "increase of supply"; the two things cancel. The demand which is important for our purposes is the demand for occupation. In the same way, more transactions for money—more purchases and sales of commodities and services—may in a sense be said to involve increase of demand for money, but in the corresponding sense it may be said to involve an equal increase of supply of money; the two things cancel. The demand which is important for our purpose is the demand for currency, not to pay away again immediately, but to
hold. Just as you are a less important demander of houses if you occupy a £1000 house than if you occupy a £2000 house, so you are a less important demander of currency if you keep on the average £5 in your pocket than if you keep £10.
It may be said that, in addition to the demand of persons and institutions for currency to
hold, there is also sometimes a demand by banks and governments for currency to
destroy, as, for example, at present in this country, when the Treasury is buying in Currency Notes and burning them. But as this demand always, or almost always, comes from institutions which have issued quantities of paper and subsequently repented, it is usually regarded as simply reducing the supply instead of increasing the demand. In favour of regarding the institution as a demander, it may of course be said that the fact that it acquires the currency to burn rather than to hold is immaterial, since it makes no difference whether the currency acquired is held or burnt, provided it is not reissued. It is, some one may say, all the same whether Currency Notes which have been withdrawn have been burnt or are stored somewhere in the Bank of England. But this is not quite true, since, if the notes were still held, they would appear in the total stock which we have agreed to call the supply, whereas, having actually been destroyed, they no longer appear in the total. Consequently it is more convenient to follow ordinary usage in this matter, and speak of banks and governments which buy up and burn currency as reducing the supply.
The supply being taken as fixed,
how much will a given increase of demand send up the value of currency? One difficulty in answering the question arises from the fact that we have no easy means of measuring increase of demand, and consequently scarcely know how to exemplify a "given increase of demand." But one example seems workable. Suppose that to a country with a particular currency of its own there is added a new province one-tenth as large and with exactly similar characteristics, which has just, by some accident, lost all its own currency, and that the annexing country creates no additional currency, but allows the new province to supply itself as best it can. We may look on this as providing, after some initial disturbance, 10 per cent. of additional demand. The people in the new province, wanting a medium of exchange, would have to give people in the rest of the country commodities and services to induce them to part with some of their holdings of currency; these sales would send down the prices of commodities and services, and correspondingly elevate the value of currency. How much in the end, when things had settled down, would depend on what we have learnt from Marshall to call "the elasticity of the demand" for currency. This has often been supposed to be what he calls "unity," which would mean that an increase of demand would cause an exactly proportional rise in the value of currency and a reciprocal fall of prices. So that, for example, in the case given above, when the new province was provided with its one-eleventh of the whole currency, prices would be down one-eleventh and the value of the unit of currency up one-tenth. We can see why if we reflect that when prices fall from eleven to ten, and £10 consequently buys as much as £11 did before, we will find it convenient to carry only £10 about with us instead of the £11 we did before. So, to induce the old country to part with one-eleventh of its stock, a reduction of prices by one-eleventh will be required and be sufficient. But we shall do well not to accept this doctrine that the elasticity of the demand for currency is always unity, till we have considered it in relation to supply. We shall then see reason to doubt it.
Given a certain demand, increase of supply, in case of any article, reduces value, and currency is no exception. The additional supply of currency is usually given by the producer, or issuer, in exchange for commodities and services, and his coming in as a new and additional buyer of such commodities and services raises the price of those things and diminishes the value of what he is offering—that is, currency. Sometimes, indeed, he gives the new currency away in doles and pensions without getting any return (except ingratitude), but this is not essentially different, since then the recipients of his gifts are the new and additional buyers.
Great confusion is often introduced at this point by neglect of the distinction pointed out by Sidgwick between increase of demand and what he calls "extension of demand." We often say that the demand for a thing has increased when we only mean that people are taking more of it because they can get it cheaper. It is obvious, however, that it is not this kind of increase of demand that we have in mind when we discuss the effect of increase of demand upon values. We could not say in the same breath that increase of demand for houses raises the value of houses, and that a fall in the value of houses causes an increase of demand for them. We can say in the same breath, that increase of demand raises the value of houses, and that the fall of value
extends the demand for them (or, vice versa, a rise of value
contracts the demand). No more in the case of currency than in any other case does the increase of supply defeat itself by causing
increase of demand. It only
extends demand, inducing people to hold more currency because the fall of value makes it possible to hold larger amounts with equal sacrifice and necessary to hold larger amounts to secure equal convenience. People will take the additional currency as they take additional whisky when it is watered and offered to them at a lower rate, but that does not show that, in the absence of increase of demand in the narrower sense, they will take additional whisky or additional currency at the old rate.
The next question is
how much a given addition to the supply of currency will raise prices and lower the value of the unit of currency? This is really the same question that we have already asked in regard to the effect of a given increase of demand. The answer is the same—it depends on the elasticity of demand, and there is the same
primâ facie reason for believing that the elasticity at bottom is unity, so that, always in the absence of any increase or decrease of demand in the narrow sense, an increase in the supply should cause an exactly reciprocal diminution in the value of the currency. But great doubt is thrown on the doctrine when we reflect that if it were universally true, issuers of legal tender could go on buying goods and services with new issues indefinitely. The process of doubling the currency in, say, the first month, would indeed gradually bring the purchasing power of the unit down to one-half, but as the issuer at the beginning would be buying very near old prices, and only at the end at the new prices, he would have acquired goods and services worth over three-quarters of the value of the total of the old currency. By another issue equal to the old currency he would only get half as much, but there is nothing to prevent him issuing twice as much in the second month, four times as much in the third, eight times in the fourth, and so on, and then he will be able to go on acquiring the same amount of commodities per month indefinitely. Experience seems to show that the unit of a currency falls to zero in value long before the supply of the currency reaches infinity, and believers in the doctrine have been unable to explain why. They have contented themselves with eluding the point by means of propositions, such as "however many kronen the Austrian Government issues, so long as they really circulate, they will always have some value, however small."
No doubt; but is it not equally true that so long as they have some value they will continue to circulate? They will stop circulating when they lose all value. The explanation seems to lie in the fact that human intelligence anticipates what is coming. When it is seen that the value of currency is steadily falling, people see that it is more profitable to hold goods than currency, the demand for currency fails to extend in proportion to the enlargement of the supply, and its value consequently falls more rapidly. The issuer very likely redoubles his efforts to keep up with the fall by issuing new currency at a still more rapidly increasing rate, but all to no purpose—he is bound to lose the race, and the reason is that the elasticity of demand is less than unity.